Argentina and Saudi Arabia: new opportunities for thrills and spills
Women across Saudi Arabia celebrated the end of their driving ban in June. A few days earlier, investors welcomed another relaxation of the rules, when the MSCI announced it would open its emerging markets index to a selection of the kingdom’s stocks from next year. At the same time Argentina will be promoted to the MSCI from the frontier index. Is this good news and how should investors realign their portfolios to reflect the changes?
On the face of it, news that a country will be included in an index can provide investors with short-term buying opportunities. Index providers are the gatekeepers of large flows of money: when a country or sector is added, passive funds and exchange-traded funds (ETFs) based on the index are obliged to buy its equities, pushing up prices. Money from active managers, whose funds use the index as a performance benchmark, usually follow soon after.
“Typically a country’s stock market performs strongly for the year between announcement and its inclusion in the index, then under performs in the year after inclusion. For the mid to long-term investor, news of an inclusion is a buying opportunity,” says Pablo Riveroll, who manages the Schroder ISF Latin American fund.
Sure enough, on the day of the MSCI announcement in June, ETFs based on the MSCI Saudi Arabia index gained 2.4 per cent, while those based on the MSCI Argentina index gained 5.3 per cent. However, investors need to be cautious in applying Mr Riveroll’s general principle. In the case of Saudi Arabia and Argentina, inclusion in the emerging markets index depends strictly on them maintaining recent structural reforms; in Argentina this means the removal of capital controls, and in Saudi Arabia it requires improved access for foreign investors.Argentina may find this hard to do. The peso has plummeted this year, inflation is at historic highs and the central bank has increased interest rates to 40 per cent.As a result, investors have deserted its equities market, which has fallen 11 per cent this year, compared with last year. By contrast, Saudi Arabia’s market, which is pegged to rising oil prices, has done well. Its Tadawul index is up 17 per cent this year from the same period last year.
History shows how investors can come unstuck if they wrongly predict a country’s promotion to the index. In 2015 it was widely anticipated that the MSCI would add Chinese equities —from which international investors have traditionally faced heavy restrictions —to the emerging markets index. In the lead-up to the decision in June, the Chinese market rose 46 per cent on the previous year. The market fell rapidly in the days after it was announced that it would not join the index; by September the gains accrued had been wiped out. “A lot of hedge funds had built up positions on the assumption that they would be added to the index and this would push prices up. When they realised they were wrong, they started selling their positions, which helped trigger a panic,” says Adam Laird of Lyxor, an asset manager.
However, a country can also suffer after it joins an index. In 2010 Israel was promoted from the MSCI’s emerging markets index to its developed market index. The country went from being a large constituent, 3 per cent, of a small index, to being a small constituent, 0.4 per cent, of a large index.
Although the passive and ETF money followed the move, active managers were slower. They can delay building their positions in countries that do not take a big share of the index, because they can do so without deviating much from their benchmarks.Mr Laird says, as a result, Israeli equities failed to reproduce the gains that frontier and emerging markets demonstrated in the following year.
Argentina, which will comprise 0.4 per cent of the MSCI emerging markets index when it joins, is more likely to suffer in this way than Saudi Arabia, which will make up 2.6 per cent.
Since June, UK investors have had a route into the Saudi market via MSCI Saudi Arabia UCITS ETF, which tracks the MSCI Saudi Arabia index. Its 32 constituents include a large number of financial and material stocks, says Lynn Hutchinson of Charles Stanley, an investment manager.For country-specific passive routes, investors can also try the US-listed iShares MSCI Saudi
Arabia ETF and Global X MSCI Argentina ETF. “However, the US listings may mean there will be dealing restrictions on some platforms and investors should be aware that neither fund is registered with the FCA,” Ms Hutchinson says.Given Argentina’s uncertain outlook, Laith Khalaf of Hargreaves Lansdown, a financial services company, suggests choosing a general Latin American fund such as the Aberdeen Latin America Fund, for exposure to the region.